Fascination with inflation: Three-minute macro

A crude awakening

The increasing importance of ESG considerations has been a powerful headwind to the energy industry, limiting flow of capital and, in turn, producers’ ability to grow and expand production, ultimately leading to tighter supply conditions. This notable tightening, paired with increasing demand from the reopening and extreme weather, has pushed energy prices up recently.

The downstream implications of rising crude oil prices have a direct impact throughout the economy. Simply put, abnormally high energy costs would effectively act as a tax on the U.S. consumer. Crude prices and energy’s share of total spending typically move in tandem. At 4% of personal consumption expenditures as of August 2021, consumer spending on energy goods and services (e.g., gasoline, heating oil, and electricity) as a share of total spending has decreased over the past seven years. With the recent move up in prices, the opportunity cost of spending more on energy is less money spent on other goods and services, eroding the bullish demand narrative associated with the reopening. We also note that increasing energy prices have a stronger negative impact on lower-income Americans, given their larger proportional share of expenditure on energy than higher income brackets. Critically, this could have a negative impact on growth, which is already at risk due to economic scarring from the pandemic.

The inflationary impacts of energy costs are likely to have even greater negative effects on growth in a global context than in the United States: In emerging-market countries, elevated energy prices create lofty inflation, and central banks will have to thread the needle to cool inflation without threatening growth and employment mandates.

Rising oil prices are pushing up spending on energy

Crude oil prices vs. Americans' energy spend

Source: Macrobond, Manulife Investment Management, as of 10/6/21. Spending on energy goods and services is measured by the personal consumption expenditures price index. WTI refers to West Texas Intermediate. LHS refers to left-hand side. RHS refers to right-hand side.

Labor force struggling to rise

Supply conditions aren’t the only thing that may contribute to rising inflation. Labor shortages are grabbing headlines across the globe as companies report being unable to fill job openings and/or to find the right people with the right skills. The data corroborates this: Compared with pre-COVID-19, there are still five million Americans who aren’t in the labor force; that is, they’re neither employed nor looking for a job. Survey data has suggested there are a host of reasons Americans (and others globally) are choosing not to look for work—from fear of COVID-19, to the need to take care of loved ones—particularly children in virtual learning—to early retirement. It’s also been long suspected that additional unemployment benefits suppressed the amount of people looking for jobs. That theory is being tested as we speak: In September, millions of Americans saw their Pandemic Unemployment Assistance expire, marking a critical inflection point in the country’s economy recovery story.

The hope is that the loss of government benefits can help the labor force participation rate recover, meaning businesses can get back to full capacity (or closer to it) and wage pressures can decline. However, September’s labor force participation rate hasn’t yet moved; in fact, it actually declined over the course of the month, from 61.7% to 61.6%. If the labor force participation rate doesn’t begin to recover, labor shortages are likely to remain problematic, and we’ll need to monitor for wage pressures more closely. Importantly, labor shortages can also weigh on production activity. A critical inflection point, indeed.

U.S. labor force participation rate has suffered, not yet recovered

U.S. labor force participation rate, by sex

Source: U.S. Bureau of Labor Statistics, Macrobond, Manulife Investment Management, as of 10/8/21. 

The gap between supply and demand: European edition

We remain constructive on parts of Europe, particularly those spaces with exposure to the manufacturing segment. Like most of the planet, the region has been subject to supply chain disruptions that have constrained its ability to produce goods. We need look no further than Germany to see evidence of this trend: In addition to broad constraints, the country’s exposure to the automotive segment has left it particularly open to the well-documented semiconductor shortage. As a result, an unprecedented gap between orders and manufacturing production has emerged.

More broadly, examples such as this are illustrations that while inflationary pressure is certainly one consideration when looking at profitability, the top-line is increasingly becoming an important consideration as disruptions are hampering companies’ ability to sell products. The silver lining here is that over the medium term, as these issues dissipate, there’s a good chance that manufacturing-centric regions will also benefit from inventory rebuilds as normalization reasserts itself.

Significant gap in German production and new orders

German orders vs. production

Source: German Federal Statistical Office (Statistisches Bundesamt), as of 10/6/21. New orders data, as of 8/31/21; production data, as of 7/31/21.